FTC Flunks First Court Test of ‘Biz-Op’ Rule

The Federal Trade Commission (FTC) loves to trumpet its new enforcement actions, new rules and big court wins through full-court media blitzes. Quite the opposite occurs when it suffers a legal defeat.

A case in point involves the FTC’s Business Opportunity (“Biz-Op”) Rule. The FTC announced the rule in March 2012 with great fanfare, holding press conferences and sending out “notice” mailers to thousands of businesses. With equal fanfare, it announced its first series of lawsuits to enforce the rule last November.

In one of these cases (disclosure: author is defense counsel), U.S. v. Zaken Corp. et al., defendants argued in opposition to a preliminary injunction motion that the rule doesn’t apply to them. In this first legal test of the regulation, a federal judge agreed, saying the rule doesn’t apply because defendants aren’t selling a “business opportunity.” Not surprisingly, the FTC PR machine hit the mute button when this unwelcomed decision came out in July.

The decision is significant because the rule, if liberally enforced by the courts, will give the FTC a powerful weapon to wield against “work-at-home” programs it sees as populated with hucksters seeking to grab the “last dollar” from Great Recession consumers. Once limited to biz-ops costing $500 or more, the rule now covers ones carrying no purchase minimum. It requires several disclosures on a prescribed form, including the basis of earnings claims. The seller must disclose, at least seven days prior to sale: a) who it is; b) whether it’s making an earnings claim; c) whether it’s had any legal trouble; d) whether it has a cancellation or refund policy; and e) a list of purchasers during the past three years. If the seller makes earnings claims, has been sued, or has a cancellation/refund policy, it must provide substantiation for the claims, identify the suits, and state the key cancellation/refund terms. The disclosure document must be provided even if the seller is not making earnings claims.

As the Zaken ruling indicates, however, in order for a work-at-home program to be subject to these requirements, it first must fit within the rule’s definition of “business opportunity.” The definition doesn’t apply to any work-at-home offer but only those in which the seller represents (in pertinent part) that it “will … provide outlets, accounts, or customers … for the purchaser’s goods or services … or buy back any or all of the goods or services that the purchaser … provides.”

The business in Zaken offers consumers the opportunity to earn a commission by locating distressed merchandise for the company to buy and sell. Purchasers are “finders” who work on behalf of Zaken to find inventory that it can choose to buy and resell to its own customers, sharing any profits with the consumer. It is akin to Internet affiliates that receive commissions on conversions from traffic they send to merchants, the only difference being that the Internet affiliate is providing customer leads and the Zaken finder is providing merchandise leads. Payment is not guaranteed, but contingent on a lead becoming a sale.

Parsing the rule’s “business opportunity” definition, the court in Zaken held that defendants don’t offer a business opportunity under the rule because: a) they do not represent that they will “provide outlets, accounts, or customers” for the purchaser’s goods or services”; b) they do not provide such “outlets, accounts, or customers;” and; c) the sales commissions their finders receive upon converted merchandise leads do not constitute a “buyback” of their services.

In reaching these conclusions, the court was heavily influenced by the contingent nature of the income opportunity offered to consumers. It noted that by the government’s own description, defendants represent only that they will “’attempt to negotiate a deal with the located company. If that deal is completed and [Zaken] can sell the merchandise at a profit,’ then Zaken will pay the consumer a portion of the profits.”

Defendants also do not provide “outlets” or “customers,” the court said, because the “excess merchandise for which Zaken arguably provides an ‘outlet’ does not belong to consumers” but to Zaken, and because the “contingency arrangement” Zaken has with consumers “does not render it a ‘customer’” under the rule. Zaken “never purchases a service” from consumers, but rather only shares profits with them from transactions to which “the consumer is not a party.” Finally, the court found, Zaken does not “buy back” anything because it:

“Does not offer to ‘provide payment’ to consumers in exchange for any service or good. Rather, Zaken in essence offers consumers an incentive to provide information that may or may not yield them some ultimate benefit. The government’s attempt to apply the rule to the contingency arrangement between Zaken and its purchasers is therefore inconsistent with [the ‘buyback’ provision], which requires, at the very least, that a seller of a business opportunity pay the purchaser for performing a service.”

Like the defendants in Zaken, Biz-Op Rule targets, in constructing their defense, need to ask themselves such questions as: 1) Do my purchasers actually become their “own bosses,” selling their own goods or services to their own customers, or are they just “finders” for my products? 2) Do I actually “provide outlets, accounts, or customers” to my customers, or am I really just offering advertising and general business help, which is exempt from the rule?; 3) If I do represent that I “provide outlets, accounts, or customers,” is it an absolute promise, or conditional?; and 4) am I required to pay my purchasers for goods or services they provide, or are there contingencies?

If you’re a work-at-home opportunity seller, and the answer to any of these or other coverage questions is no, then, as Zaken shows, the heavy-handed Biz-Op Rule may not apply to you.

William I. Rothbard is a former FTC attorney and practices in Los Angeles, specializing in advertising and marketing law. He can be reached at (310) 453-8713,Rothbard@FTCAdLaw.com, andwww.ftcadlaw.com.